8 Money, credit and inflation
8.3 Credit, money and inflation
Marxian analyses of money, credit and crises can be developed in different directions, in order to illuminate a broad range of contemporary pheno- mena. This section illustrates the potential usefulness of these approaches through a critical review of three theories of inflation emphasising, respec- tively, distributive conflicts, monopoly power and state intervention on the dynamics of credit money.32This is important for three main reasons. First, inflation poses an intriguing theoretical challenge.33 Mainstream analyses, usually inspired by the QTM, have unacceptably weak foundations, including perfect competition, full employment and costless adjustment between static equilibria. In contrast, Marxian (and other political economy) contributions are promising, but remain relatively undeveloped. Second, advances in the understanding of inflation can easily be extended to the study of deflation, and both are currently important.34 Third, inflation and conventional anti- inflation policies usually have high economic and social costs. They often lead to higher unemployment, lower real wages, higher rates of exploitation and shift the income distribution and the balance of social forces towards capital and, especially, financial interests. It would clearly be important to develop alternative analyses, in order to confront inflation and the conse- quences of conventional anti-inflation policies.
Two difficulties have frustrated attempts to develop Marxian analyses of inflation. First, inflation is a highly complex process that involves a wide range of determinants at different levels of abstraction, among them pro- duction, the supply of money, interest rates, the industrial and financial Money, credit and inflation 99
structure, external shocks, distributive conflicts, and many other variables.
It is very difficult to order these influences systematically within a cogent theory. Second, it is especially difficult to explain inflation in inconvertible monetary systems, drawing on the anti-quantity theory tradition of Steuart, Tooke, Marx, Kalecki, and most post-Keynesians writers. Simply put, it is difficult to develop a theory of inflation whilst simultaneously preserving the claim that the needs of production and trade call money into circulation (endogeneity), and admitting that money may influence ‘real’ variables (non- neutrality). This exercise becomes even more complex when it involves different forms of money, issued by the state and by the commercial banks, each of them with a particular relationship with capital accumulation. In spite of these difficulties, this section shows that it is possible to outline the general conditions for inflation.
Conflict inflation
Non-mainstream economists of very different persuasions, including many Marxists and most post-Keynesians and neo-structuralists, argue that distributive conflicts are usually the most important cause of inflation (this approach is appealing to some Marxists because it apparently vindicates the notion of class struggle).35
Conflict analyses are inspired by cost-push theories, which were popular between the 1950s and the 1970s. They usually depart from equilibrium, and assume that the money supply is fully endogenous, that fiscal and monetary policies are passive, and that key agents (especially the monopoly capitalists and unionised workers) have market power and can set the price of their goods or services largely independently of demand. Inflation arises because the central bank validates incompatible demands for shares of the national income through monetary accommodation or its support for the financial system, in order to ensure financial stability and the continuity of pro- duction.36The inflation rate is usually a positive function of the size of the overlapping claims, the frequency of price and wage changes and the degree of capacity utilisation, and a negative function of the rate of productivity growth (the basic model can be refined endlessly by incorporating target income levels, expectations, reaction functions, and limits on the wage claims because of unemployment, or on the mark up because of competition).
The most important shortcoming of the conflict approach is the absence of a clear internal structure. This approach is compatible with widely different theories of value, production, employment, demand, income and distribution, and with different rules of determination of the target income levels. Classes are sometimes seen as partners, in which case it is relatively easy to achieve economic stability through negotiated incomes policies.
Alternatively, a theory of exploitation may be used; in this case, economic stability can be achieved only through the subordination of the workers by force. This flexibility makes conflict analyses potentially appealing to a wide 100 Money, credit and inflation
audience; however, it is vulnerable to the charges of arbitrariness and lack of analytical rigour. In particular, inflation generally starts from a dislocation that shifts the economy away from a Pareto-optimal equilibrium. ‘Appor- tioning blame’ is, therefore, implicitly at issue, and alternative economic policies are usually assessed in terms of their ability to make the economy return to the initial equilibrium. It is not usually explained how that equilibrium was originally determined, or why it merits return. Moreover, it was shown in sections 2.2.2 and 4.1 that capitalists and workers do not confront each other directly over the shares of the national product, firstly because the wages are advanced, whereas profit is the residualand, secondly, because disputes generally involve income levels rather than shares.
Indeterminacies such as these can be eliminated only through an organic relationship between the conflict approach and a broader economic theory.
Unfortunately, many such connections are possible, and none is necessary. In other words, conflict theories, as they are usually presented, are typically
‘middle range’.37They derive from a set of stylised empirical observations (e.g., agents exercise claims over the national product through the sale of their goods), and transform these observations into structures that are used to explain these stylised facts (e.g., distributive conflict leading to inflation).
This approach conflates cause and effect, because it presumes that, since inflation has distributive implications, income disputes cause the process; and the analysis is unsound because it is not grounded by a broader structure that supports its elementary concepts and contextualises its conclusions. The lack of a theory of production implies that the state’s role and policies cannot be adequately grounded either, and they usually derive from a further set of stylised facts. Consequently, the rationale for, and the power of, economic policies are left unexplained and depend heavily on the analyst’s preferences.
In spite of these important limitations, the conflict approach is potentially relevant. Distributive conflicts must be part of any inflation theory, for infla- tion would not persist in the absence of dissatisfaction about the level and/or distribution of the national income, and the monetisation of these claims.
Monopoly capital, underconsumption and inflation
Many Marxists argue that inflation is associated with the increasing market power of large corporations and underconsumption, most clearly for the monopoly capital school.38This approach argues that monopolies are the most dynamic firms and the largest investors, employers, producers and exporters. In order to maximise economic growth the state supports the monopolies through purchases, cheap infrastructure, tax breaks, subsidies for research and development, and so on. More broadly, the state spends huge sums in civil servants’ wages, consumables and public investment, funds health, education and defence expenditures, and makes large transfers associated with social security. These expenditures support monopoly profits Money, credit and inflation 101
directly through purchases, and indirectly through transfers to their customers. Interventionist policies of the welfare state delivered un- precedented economic stability, high employment and rapid growth, especially between the late 1940s and the late 1960s. However, they also contributed to persistent budget deficits, rising public debt and creeping inflation. In sum, inflation is the result of interventionist economic policies trying to ensure full employment and social stability, in an economy constrained by mono- poly power and pricing strategies.39
These are important insights, but this approach is theoretically fragile. It does not include a theory of monopoly power or pricing, other than a collation of the ideas of Hilferding (for whom monopolies impose prices above the prices of production in order to reap extra profits) and Kalecki (for whom monopoly power is a stylised fact and monopolies reap extra profits because of their market power).40The influence of monopoly on the circuit of capital and income distribution is not explained, and the role of demand and other limits and counter-tendencies to the concentration and centralisation of capital are almost invariably ignored.
The theory of the state is also left unclear, and what is said is potentially contradictory. On the one hand, the state manages the economy relatively autonomously in order to ensure the reproduction of capital as a whole, which requires the accommodation of the interests of different fractions of capital and of the workers, and is best achieved in a democracy. On the other hand, the state is a tool of powerful (monopoly) interests, and its policies are limited by the need to obtain their consent, in which case fascism is a clear possibility. Finally, the linkages connecting monopoly power, state policies and inflation are left mostly unexplained. There is no clear theory of money, credit or finance, except for the presumption that money supply responds passively to monopoly demand or to state command, and that (largely unexplained) financial developments are contributory factors. How this leads to inflation is left unclear.41 More generally, the causes of inflation shift between monopoly pricing decisions and excess demand induced by the state (which is, paradoxically, the result of state attempts to avoid undercon- sumption).42 The distributive impact of inflation is not analysed, except to argue that monopolies benefit at the expense of the workers and other groups receiving nominally fixed revenues. It is unclear how this relates to the theory of wages or of exploitation.43
Extra money inflation
In the mid-1970s an alternative analysis was outlined, in which inflation is the result of a permanent increase in the relationship between commodity prices and values, caused by a discrepancy between the supply and social demand for money.44
The analysis departs from the circuit of capital. The productive circuit begins when capitalists draw on previously accumulated funds or borrow 102 Money, credit and inflation
newly created credit money in order to finance production. Injection of these funds into the economy increases the ratio between circulating money and output value. If more output is produced and sold additional income is created, which cancels out the initial shift in the relationship between money and value. However, if the output cannot be sold at its price of production the firm suffers a loss that may be absorbed in two ways. If ‘market rules’ are respected, a well-defined set of agents bears the cost, usually the firm or its bank. This type of solution can be destabilising, because it may system- atically lead to unemployment, capacity underutilisation, the deterioration of the working conditions, and financial fragility.
Alternatively, the loss may be socialised if the debt is refinanced or if the firm receives a state subsidy (in the extreme, it may be nationalised and
‘restructured’ with public funds). In either case, there is an injection of purchasing power that perpetuates the initial discrepancy between the circulating money and the output; in other words, the initial (presumably transitory) increase in the monetary equivalent of labour becomes per- manent. The money injected into the economy through a violation of ‘market rules’ is extra money.45Extra money may also be created by central bank support to the financial institutions, by non-sterilised balance of payments surpluses, or by corporate or household dissaving or borrowing for specu- lative purposes.46Extra money typically increases the nominal income or the liquid wealth of the consolidated non-financial sector in spite of the constant value of the output, and regardless of the existence of equilibrium, currently or in the past. If the extra money induces a quantity response, the previous relationship between value and money may be restored; otherwise, the monetary expression of labour rises: this is extra money inflation.
Extra money inflation may be facilitated by the monetary policy stance, but the state cannot be generally ‘blamed’ for it because extra money is routinelyand necessarily created by private decisions that are not subject to state control (including bank loans). Moreover, even if the extra money is created by the state it is impossible to know in advance whether it will have a quantity or price effect, or both (targeting is possible, but necessarily imprecise). In due course, discrepancies between the quantity of circulating money and demand will tend to be eliminated by changes in output, velocity or hoards. However, these adjustments take time, and they may create additional instability through their effects on prices, the exchange rate, the balance of payments or the interest rate. If these monetary discrepancies are continually renewed, they can lead to persistent inflation, severe balance of payments disequilibria and prolonged economic stagnation, which demon- strate the non-neutrality of money and its potential influence over the accumulation process.
Long-term inflation may derive from the attempt by the state to deliver continuous economic growth, or from the attempt to avoid deflation when growth falters. More generally, in the upswing, extra money is provided mainly by the private sector with the support of the central bank, in order Money, credit and inflation 103
to finance consumption and new investment. Therefore, growth necessarily breaches the established relationship between value and money, and it is always potentially inflationary (depending on the supply and import responses). As the economy grows, disproportions and bottlenecks inevitably develop, financial structures become more fragile and, unless cheap imports are readily available, prices (and, possibly, wages) tend to increase. At this stage, the crisis erupts either spontaneously, because of the balance of pay- ments constraint or because contractionary policies have been adopted. If the crisis becomes acute and deflation looms, the state will usually intervene and deliberately inject (or facilitate the private creation of) extra money.47
In spite of their apparent similarity, the theory of extra money inflation is incompatible with the QTM. The quantity theory’s assumptions that money supply is exogenous, that money is only a medium of exchange and that money is not hoarded are unacceptable from the perspective of the extra money approach. First, this approach argues that extra money is regularly and spontaneously created by the interaction between the central bank, commercial banks and firms, and that its quantity cannot be controlled, or even known precisely, by the state. In contrast, the quantity theory presumes that the banking system is always fully loaned up, and that the central bank can determine autonomously the supply of money directly (through the monetisation of government budget deficits or purchases of government securities) or indirectly (through changes in compulsory bank reserves, which should lead unproblematically to changes in the outstanding stock of loans).
Other sources of changes in the supply of money are usually ignored, and the possibility that changes initiated by the central bank may be neutralised by hoarding, loan repayments or by a compensatory change in bank loans are generally neglected by the QTM.
Second, extra money is non-neutral in the short and in the long run; it may change irreversibly the level and composition of the national product and the structure of demand, depending on how it is created and how it circulates. In contrast, the QTM presumes that money is neutral in the long and, in extreme cases, even the short run. Third, the effects of extra money (whether quantity, price, or both) cannot be anticipated. All that one can say is that high capacity utilisation and activist state policies increase the probability of extra money inflation, but there is never a simple relationship between them. In contrast, for the QTM the relationship between money supply and inflation is usually straightforward. Because of the underlying assumptions of perfect competition, full employment, and money neutrality, a change in the supply of money (initiated by the central bank and automatically propagated by the commercial banks through the money multiplier) unproblematically leads to a predictable change in the price level.
The extra money approach can provide the basis for the development of a theory of inflation which incorporates the main claims of the labour theory of value, and the valuable insights of other Marxian analyses of inflation.
However, this approach is still undeveloped at critical points, and it suffers 104 Money, credit and inflation
from deficiencies and ambiguities that need to be addressed urgently. For example, the analysis of the supply of central bank and credit money is usually simplistic, and it would benefit from greater exposure to, and con- frontation against, recent post-Keynesian developments,48circuitist contri- butions,49and the works of Kalecki.50 At a more concrete level of analysis, the valuable contributions of Minsky on the financial instability of modern capitalism need to be evaluated in detail and incorporated into the analysis when this is warranted.51
In addition to this, much work remains to be done in order to make the structures and categories in the extra money approach fully compatible with those of Marx’s theory of value. For example, the relationship between the supply of money and the monetary expression of labour is usually left unclear, the extra money approach often shifts arbitrarily between levels of analysis and leaves ambiguous the stature of competition. Finally, further work is necessary to distinguish between price increases caused by extra money and those caused by other types of money supply growth. This would help to clarify the residual ambiguity between the extra money approach and the quantity theory of money, especially with respect to the role of excess demand as the trigger of inflation.
Addressing these issues systematically will make it possible to incorporate other important phenomena into the analysis, for example financial develop- ment and financial and capital account liberalisation. It will also make it possible to analyse concrete problems such as the potentially inflationary impact of the public debt overhang, whose increasing liquidity may be synonymous with the injection of extra money into the economy.52